By Pete Biebel, Senior Vice PresidentPrint This Post
In the popular poker game, Texas Hold ‘Em, players are dealt two cards facedown. Then five community cards are placed face-down in the middle of the table. Those cards are revealed in three steps. First, three cards are turned up simultaneously. This is “The Flop;” players then have much more insight into whether the cards they hold have a chance of making a strong hand. Following a round of betting, the fourth card, “The Turn” is revealed. Now, with just one more card to come, players have a good idea how many potential cards can help their hand and how likely their hand is to hold up against other possible hands. There’s another round of betting, then the final card, “The River” is exposed. Was it good news or bad news? Did it improve one’s hand, or did it likely help another player more?
The five trading days last week played out like a game of Hold ‘Em. Recall that in the prior week the broad averages sold-off steeply. Both the NASDAQ Composite Index (COMP) and the S&P 500 Index (SPX) briefly punched below their 200-day moving averages. At that time I wrote, “The averages should be able to rally steeply through the vacuum created by last week’s plunge. They should be able to quickly reclaim and rise above those 200-day levels.”
And indeed, they did. The market caught a good Flop. The first three days of the week, and particularly the moon-shot rally on Tuesday, recovered between one-third and one-half of the losses sustained over the previous eight sessions. I should point out that the volume on Tuesday’s monster rally was the lowest NYSE total volume so far this month; that’s indicative of the “rally through the vacuum” nature of the rebound. Nevertheless, players were feeling much more optimistic that the market would be in good shape at the end of the week.
Thursday’s session, the Turn, was not so good. The major averages gave back nearly all the week’s gains. It was the highest volume session so far in the week. All the averages finished near their lows of the day, and COMP and SPX were right back at their 200-day averages. It was a session that clearly helped the bears’ hand more than the bulls’. The bulls were going to need a heck of a River card on Friday.
Unfortunately, the market’s inability to hold on to an opening rally on Friday morning was an indication that the final session of the week was not likely to improve the bulls’ hand. Despite those promising early gains, the major indices dipped into the red around midday and ended the session near unchanged. The Dow Jones Industrial Average (DJIA) gained about one-quarter percent on Friday, lifting its gain for the week to 0.41%. SPX lost 0.04% on Friday, reducing its gain for the week to a scant 0.02%. COMP dropped nearly one-half percent that day, increasing its net loss for the week to 0.64%.
Early in the week, it looked as if the market had been dealt a strong hand, but by Friday, it was apparent that the market had thrown in its cards. The explosive Tuesday rally was just enough to get the bulls to contribute a few more chips to the pot. But, when those gains were given back later in the week, it became apparent that the bears had the upper hand.
Last week I suggested that, as an indicator of how likely COMP and SPX were to hold above their 200-day moving averages, we watch four particular sectors to see how they perform with respect to their own 200-day moving averages. Two sectors, Basic Materials and Industrials needed to reclaim their 200-day averages. Sadly, neither did and both sectors suffered net losses for the week. Two other sectors, Consumer Discretionary and Technology needed to rally quickly away from their 200-day averages, which they had briefly dipped below at their lows late in the prior week. Both appeared to be on their way to doing just that after the big Tuesday rally, but both sectors gave back all their early-week gains over the next two days. Both sectors ended the week with net losses, with the Consumer Discretionary sector ending the week below its 200-day moving average for the first time in more than two years.
With Friday’s declines, COMP closed slightly below its 200-day moving averages. SPX closed pennies above its 200-day. Both indices spent a day or two below their 200-day averages in the prior week, but quickly reclaimed those levels. Sustained trading below those levels could open the door for a retest of the February/April lows. Because those indices have been able to hold at their 200-day averages on each of the several occasions over the past few years, a break of those averages now could be a loud and clear message. A break of those averages that subsequently also takes out the October 11th lows is likely to trigger another wave of selling by quantitative, mechanical and trend-following systems.
The reason I chose to use the word “taxes” is in this week’s title is that I was recently reminded of how the tax implication of closing out a position is often too high on some investors’ lists of priorities. A friend said he couldn’t sell such-and-such stock, which he has owned for several years, because the tax on the gain would be so large. Yet, I suspect that if I had asked him a year ago, “How much of that stock would you sell today if you didn’t have to pay any tax on the gain?” I think he would have been willing to sell most, if not all his shares. Now, a year later, with his stock much higher than it was a year ago, he “can’t” sell even though the after-tax proceeds would be much greater than the total proceeds a year ago. Out of his aversion to paying taxes, he’s in a state of permanent “hold ‘em.”
One pattern that has become evident since mid-summer is that many of the stocks that have racked up spectacular gains over the last couple years, and led the market higher, have suffered steep declines. They’re still well above year-ago levels, but they’ve given up a big chunk of their 2018 gains over the past month or two. Investors who have been fortunate enough to have ridden some of those names to fat gains should consider lightening up on such positions, even in taxable accounts, especially in those stocks that are trading at dot-com era valuations.
This will be the busiest week yet in the new earnings season. Gap openings, both up and down, in individual stocks in reaction to earnings news could be a daily occurrence. This week’s economic calendar doesn’t offer much that’s likely to generate any gap openings for the overall market. The Durable Goods data on Thursday and the GDP number on Friday are the likely highlights.
|Monday 10/22/2018||Chicago Fed National Activity Index||0.18||0.18|
|Wednesday 10/24/2018||New Home Sales, SAAR||629K||625K|
|Thursday 10/25/2018||Durable Goods Orders, M/M||+4.5%||-1.4%|
|Durable Goods Orders, ex-Transportation, M/M||+0.1%||+0.4%|
|Initial Jobless Claims||210K||212K|
|International Trade in Goods, Trade Deficit||$75.8B||$74.4B|
|Pending New Home Sales, M/M||-1.8%||0.0%|
|Friday 10/26/2018||GDP, Q/Q, SAAR||+4.2%||+3.3%|
Links to previously published commentaries can be found at benjaminfedwards.com/Company News/Blog/Market.
Benjamin F. Edwards & Co. does not provide tax advice, therefore it is also important to consult with your tax professional for additional guidance tailored to your specific situation.